American Oil and Gas Reporter - March 2016 - 35

SpecialReport: Market Analysis

Sloping Foundation
The simplest and most transparent of
the pick six issues being bandied about
as a price driver is U.S. oil production,
specifically the supposed resiliency of
onshore tight oil resource plays. Certainly,
the unconventional revolution has been a
huge factor in global production increases.
However, the item not generally recognized
is that production typically lags drilling
by some five months, so that drilling in
December 2014 is discernible in production records in April 2015. That analysts
were alarmed at increasing production
and supply during the first half of last
year suggested that they did not understand
this dynamic, nor did much of the American business press.
Figure 1 shows production from U.S.
onshore unconventional plays over the
past six years. Note that the lag in production reporting means fourth-quarter
2015 reports, and even some third-quarter
2015 reports, are not finalized. Drillinginfo's analysis predicted in April 2015
that monthly production would peak in
May, and then jump around between net
declines of 100,000 and 350,000 barrels
a day for the rest of the year.
When looking at additional production

month over month, it is important to remember that it is building on a sloping
foundation of natural decline. For instance,
in 2014, as U.S. supply added some 1
million barrels of daily production, it had
to produce 2.2 million new barrels a day
of oil production to do so. The slope of
that foundation required 1.2 million new
barrels a day simply to flatten the decline
curve.
First-year U.S. oil production has had
a blended annual decline that has increased
from 41 percent for 2010-era wells to 47
percent for 2013-era wells. Therefore,
wells drilled in 2014 were likely to have
declined by 49 percent in their first year
of production, and 2015 wells by 51 percent. Second-year declines show less of
a pattern, ranging from 10 to 20 percent
from the end of the prior year.
Real Production Declines
In other words, we will see real production declines in 2016 as the full impact
of severe 2015 drilling reductions is
cycled through. Depending on the variability of second-year declines, the amount
of U.S. oil production lost by the end of
this year could range from 400,000 bbl/d
to more than 1 MMbbl/d (and this will
come on top of the production lost in the
second half of 2015).
Lending clear support to projected
production declines, the February Drillinginfo Index showed U.S. new production
capacity (NPC) for both oil and gas falling
by a whopping 24 percent, to 475,000
barrels oil equivalent a day (from 621,000
boe/d in January). Looking at crude oil
only, U.S. NPC decreased 12 percent in

February, to 261,000 bbl/d. The index is
reflective of wells drilled in the previous
month and is usually a forward indicator
of what production may be in five to six
months.
So, given the marked slowdown in
new oil production capacity, and the
impact of decline rates on the existing
production base, the United States is not
going to be the bringer of "oil glut news"
going forward, and should not drive a
low-price sentiment. In fact, the domestic
oil patch has severely damaged its capacity
to rebound from an oil field services
point of view, with companies foregoing
normal maintenance simply to survive.
This deferred maintenance will have permanent consequences.
It should be noted that the February
Drillinginfo Index found an even more
precipitous slide in new gas production
capacity, with natural gas NPC falling
35 percent, to 1.28 billion cubic feet a
day. Since May 2014, U.S. natural gas
NPC has decreased by 58 percent, with a
continuous decline in the Appalachian
Basin leading total U.S. gas NPC on a
downward slope since March 2014 (Figure
2). The new absolute low in the Appalachian Basin may show the beginning
of the capitulation that some observers
think may lead to the firming of market
prices and a rebalancing of the North
American natural gas market.
Supply, Demand Perceptions
How about the perception that Saudi
Arabia has the ability to further grow its
production? Whereas Saudi Arabia's rig
count is up, so is its production, which

FIGURE 1
Oil Production from U.S. Unconventional Onshore Plays (2009-15)
200,000

180,000
North American Unconventional Production (Mboe 20:1)

What, exactly, will that future look
like? Today's pricing sentiment is driven
by a "pick six" of global economic factors:
* U.S. production rates;
* Saudi Arabia's ability (or lack thereof) to grow production;
* Iran's latent ability to produce more
oil with the lifting of international sanctions;
* China's economic slowdown and
its impact on consumption;
* Russia's ability to add global production; and
* The Organization of Petroleum Exporting Countries' inscrutable strategy.
Before getting into these issues, let us
stipulate a couple key assumptions:
* Producing companies and/or nations
will produce existing wells at rates that
are not sustainable to preserve cash flow
or compete for market share because the
cost to drill and bring new production on
line is sunk already.
* New wells will not be drilled if
there is not at least an outlook to break
even producing them. That means an expectation of a sustained price over onethree years, or until the well has been
paid out.

160,000

140,000

Color by:
Production year
2009
2010
2011
2012
2013
2014
2015

120,000

100,000

80,000

60,000

40,000

20,000

A S O ND J F MA M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N
Q3 Q4
Q1 Q2
Q3 Q4
Q1 Q2
Q3 Q4
Q1 Q2
Q3 Q4
Q1 Q2
Q3
Q4
Q1 Q2
Q3 Q4
Q1 Q2
Q3 Q4
2009
2010
2011
2012
2013
2014
2015
Production Date (Month)

MARCH 2016 35

American Oil and Gas Reporter - March 2016

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